We Don’t Need No Stinking Incentives!

Two news stories caught my attention recently, both for revealing the federal government’s (and particularly the executive branch) shocking ability to ignore one of the basic laws of economics and psychology (and maybe sociology, but I never studied much of that). Pretty much both of these fields agree, to a greater or lesser extent and for various reasons, that people will respond to incentives. In psychology they call it things like “positive and negative reinforcement”, but apparently in the government they call it “ignore the consequences and just do things you want because the ends always justify the means”.

The first of these stories was a report by the Washington Post that President Obama is leaning on banks to “make home loans to people with weaker credit” (direct quote from headline there). According to the Obama administration, lenders should “use more subjective judgment in determining whether to offer a loan”. Personally I find that a little disconcerting, since according to that same article “since the financial crisis in 2008, the government has shaped most of the housing market, insuring between 80 percent and 90 percent of all new loans, according to the industry publication Inside Mortgage Finance.”

Hey, what’s the key phrase in that last sentence? Was it “financial crisis in 2008”? Why yes, yes it was. I seem to vaguely recall that one. It was triggered by something… let me think… oh, that’s right, a housing bubble driven in large part by risky borrowing, which has been attributed by some (including me) in large part to government policies pushing for more home ownership and led to a bail out of Fannie May and Freddie Mac. But they’re cool now, right? Let’s go back to the Washington Post for confirmation: “the government has shaped most of the housing market, insuring between 80 percent and 90 percent of all new loans…primarily through the Federal Housing Administration, which is part of the executive branch, and taxpayer-backed mortgage giants Fannie Mae and Freddie Mac.” Oh. But that’s not a problem, is it? “If borrowers with FHA loans default on their payments, taxpayers are on the line” – and we’ve already bailed out Fannie and Freddy once before in recent memory.

So what we have here is a political agenda that completely ignores not just economic law and historical trends but recent memory in favor of “doing the right thing” and wishful thinking. Because that’s never caused us any problems before. Here’s a thought: maybe the banks are being overcautious, but they have reason to be. Or maybe they’re being just as cautious as they should be, given that the market hasn’t sufficiently recovered yet. I honestly don’t know. And lest I be accused of being a demagogue, let me point out that I’m arguing against my own interests here. As I’ve noted before, I’d be much better off if the banks started giving out easy money again, because then my wife and I could buy a house (we passed on the last round of insanity). However that’s in the short term, and in the long term it would just be inviting disaster.

But never let it be said I’m not an equal opportunity hater. The other story that got my attention was an indictment of three dozen Atlanta educators for cheating in standardized tests. While the indictment only goes back to 2005, I seriously doubt someone said “Hey, George Bush wouldn’t like this, but I’m sure President Obama would have no problem with it!” More importantly, President Obama wasn’t responsible for the landmark legislation that is the proximate cause for the cheating scandal: No Child Left Behind and the high-stakes testing it engendered.

It’s not just high-stakes for the kids; these teachers apparently had everything on the line, from bonuses to their jobs. Who did they hire as their motivational speaker, Alec Baldwin? I’m in no way condoning what they did, because the people who really got punished are the students. Either they didn’t get the education they were promised or they will always be haunted with the uncertainty of whether they really earned that grade.

But it comes back to incentives, and another phrase from economics, “unintended consequences”. Nobody intended for people to cheat, certainly not teachers and administrators. But the incentives were lined up for them to do just that, just as the incentives are lined up for the common complaint (which I most often hear from teachers) of having to “teach to the test”. Once again we have a case of a political agenda that completely ignores economic laws and (proven after the fact for years) reality in favor of “doing the right thing” and wishful thinking, only in this case we have a clear case of it biting us in the ass right in front of us that is bizarrely reminiscent of a Hollywood movie plot. Unfortunately in this case the underlying problem hasn’t been resolved; we’ve removed the symptom but not the cause.

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5 Comments on “We Don’t Need No Stinking Incentives!”

I don’t know facts like you and I’m not politically astute. I just resort to common sense in my daily life. My adivce is the best way to buy a house and to me secure is to save your money, is to save your money, count your pennnys. I don’t knowabout President Obama’s plan but personally I don’t like to borrow or loan money. I will if I have to though,

It’s astonishing how rarely people pay heed to the consequences of the incentives they set up. You have cited a couple cases in the public sector, but I see it all the time at the corporation where I work. We wonder why our retail stores and website aren’t performing the way we’d like them to, and may even acknowledge that our corporate employees are making ‘iffy’ decisions, but ignore the fact that these decisions are the *direct and obvious* consequence of the incentives placed on them.

On a completely different note, I’m quite amused by the anatomically improbable turn-of-phrase you use: “biting us in the ass right in front of us”!

You make an excellent point, Gabriel, and at least in theory the point of the private market is that when companies ignore those incentives the consequences do come back on them, and sooner or later overwhelm them. The companies that pay attention and shape incentives appropriately should flourish (in the long run). Government, by its very nature, is compulsory; no matter how bad or inefficient or poorly run (or contrariwise, how beneficent and well-run) it may be, the citizens are still forced to obey. And when the government ignores incentives, the result is the citizens pay.

We have had similar issues here in the UK with our education system. The old CSE, O and A level exams and streaming system that I grew up with which I considered a fair system even though it meant that many of my age group rarely achieved high grades. Most people including myself generally got B or C grades. However those middling grades were over a far more diverse range of subjects. I took twelve O levels when I was sixteen and four A levels at eighteen, these days it is not uncommon for most pupils to sit just half a dozen exams in total.

The system was regarded as unfair as those pupils that were not academic types, didn’t study or were troublesome ended up being placed into lower streams and then did CSE’s (the least testing exams but also the least value for future employment) and generally went on to college whereas those in upper streams did O and A levels and went to university or straight into higher paid jobs in industry. This was all deemed unfair to the ‘poor’ and was scrapped.

It was replaced in the late 80’s with a new set of exams that all pupils sat. Streaming was also stopped. In addition the government introduced incentives for schools to get a minimum number of passes and/or higher grades and that is exactly what was done. Schools concentrated on a few subjects that were easier to achieve passes in than subjects that might have been more suitable for the long term good of both student and economy. Thus maths and sciences were sidelined in favour of less demanding subjects. Thus we got to the point were pupils were getting three or four A grades in these subjects and the school and government met its targets but at the loss of diversity in the education each pupil received. This has thankfully now changed and Maths and Sciences are once more being placed at greater importance.

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